Put Option Clauses – A Growth Chart

The validity of put option clauses in contracts has been a subject of detailed scrutiny for the Indian government, for several years. The discourse surrounding put option clauses originated from Section 20 of the Securities Contracts (Regulation) Act, 1956 (“Act“)—which was subsequently omitted by the 1995 amendment to the Act (“Amendment“).  The earlier section stipulated that all options in securities would be illegal, leaving stakeholders distraught. However, the aforesaid repeal pursuant to the Amendment did not put this matter to rest, as a notification issued by the Ministry of Finance in the year 1969 was still in force. This notification provided that contracts for sale or purchase of securities which were not spot delivery contracts or contracts for cash/hand delivery/special delivery in any securities would be disallowed altogether.

Although the Amendment did not address the matters disallowed by the Notification expressly, the Securities and Exchange Board of India (“SEBI“) issued a notification on March 1, 2000 (“2000 Notification“) which stated that no person shall “enter into any contract for sale or purchase of securities other than spot delivery contract or contract for cash or hand delivery or special delivery or contract in derivatives” as is permissible under the applicable law. However, this notification did not settle the issue of put option clauses either.

The Act was amended again in the year 1999; where a new section was inserted (Section 18A), which stipulated that notwithstanding other applicable laws, contracts in derivatives would be legal and valid if they are traded on a recognized stock exchange and settled on the clearing house of the recognized stock exchange in a lawful manner.

Ultimately, the position of law was laid out clearly by the SEBI in its notification dated October 3, 2013 (“2013 Notification“). This notification rescinded the earlier notification the SEBI issued in the year 2000 and proceeded to stipulate that “contracts in shareholders agreements or articles of association for the purchase or sale of securities pursuant to the exercise of an option contained therein to buy or sell the securities” would be permissible in the event the following conditions were met:

(i) the title and ownership of the underlying securities is held continuously by the selling party to such contract for at least a year from the date of entering into the contract;
(ii) the price or consideration payable for the sale or purchase of the underlying securities pursuant to exercise of any option contained therein is in compliance with the applicable law; and
(iii) the contract is settled by way of actual delivery of the underlying securities.

Further, the 2013 Notification contained a proviso stating that the contents thereof would not affect/validate any contract entered into prior to the date of the 2013 Notification.

On February 2, 2023, a Division Bench of the Bombay High Court, in the case of Percept Finserve Private Limited v. Edelweiss Financial Services Limited  held that a put option clause contained in share purchase agreements would be legally valid under the provisions of the Act and the notifications issued thereunder.

The share purchase agreement in question was entered into on December 7, 2008 i.e., prior to the date of the 2013 Notification. In light of the aforesaid proviso, the court was urged to consider the effect of the 2000 Notification. The court observed that put options are not “forward contracts for sale or purchase of securities” and that the contract’s obligation would only realize (if at all) upon the occurrence of a future contingency and more specifically, upon the exercise of the option by a party.

Additionally, the court considered whether the aforesaid put option in the agreement amounted to making of a “contract in derivatives”; thereby attracting the embargo under Section 18A of the Act. The court found that a put option is not a “contract in derivatives” either and that Section 18A does not, in itself, make any particular contract illegal or invalid. It was held that the applicable law (i.e., the Act and the 2000 Notification) does not prohibit one from entering into a call or put option for sale (and instead, prohibits trading or dealing in such option treating it as a security).

The clarification provided by the Bombay High Court by way of the aforesaid judgement clears the discrepancies in relation to put option clauses in contracts entered into prior to the 2013 Notification; by providing a much needed framework within which put option clauses in such contracts pre-dating the 2013 Notification may be read, interpreted and enforced.